In December the Cato Institute launched its Distinguished Lecturer Series with an address by F.A. Hayek, 1974 Nobel laureate in economics and author of numerous books, including The Road to Serfdom; The Constitution of Liberty; Prices and Production; Monetary Theory and the Trade Cycle; and Law, Legislation, and Liberty. Professor Hayek is now working on a book entitled The Fatal Conceit, which will deal with socialism and central planning in all its forms. Before his lecture, Professor Hayek granted the following exclusive interview to Policy Report.

Policy Report: What role can a public policy institute, like the Cato Institute, play to limit the size of government and increase individual freedom?

Hayek: Well, I can’t speak about particular institutes, but the one institution of that sort which I have watched from the beginning and for the existence of which I am in some sense responsible, is the Institute of Economic Affairs of London, which was created by Antony Fisher. He thought you could sway mass opinion. What I insisted and what was strictly followed by the Institute was not to appeal to the large numbers, but to the intellectuals. My conviction is that, in the long run, political opinion is determined by the intellectuals, by which I mean, as I once defined it, the secondhand dealers in ideas—the journalists, schoolmasters, and so on. In fact, socialism is very largely an affair of the intellectuals and not the working class.

So the Institute began publishing little brochures or pamphlets dealing with a few political issues on a level intelligible to the intelligent, but not technically educated, person. They are not writing for the economist, nor for the general public, but for the educated man, represented by schoolmasters and journalists and so on.

It has taken a long time to prove its success. And for a time I did wonder whether or not I was thinking correctly. I now think it has become the most powerful maker of opinion in England. By now, book shops usually have a special rack of Institute of Economic Affairs pamphlets. Even people on the left feel compelled to keep informed of the Institute’s publications. And I think that if you are looking for a program here in the United States, you can do no better than to study the Institute’s publications catalogue.

PR: Do you think monetarism has failed? And what would be wrong with enforcing a monetary rule that limited the growth of high-powered money?

Hayek: I don’t know what monetarism is. If monetarism just means a good old-fashioned quantity theory, of course it has not failed. If it means the particular version of Milton Friedman, I think it has because he imagines that he can achieve—ascertain—a clear quantity relationship between a measurable quantity of money and the price level. I don’t think that is possible. In fact, just about 40 years ago in the opening sentences of my book, Prices and Production, I wrote that it would be a great misfortune if people ever cease to believe in the quantity theory of money. It would be even worse ever to believe it literally. And that’s exactly what Milton Friedman does. He imagines that it is possible to prescribe to the monetary authorities a definite rate at which “the ” quantity of money must be allowed to increase. I must say that I don’t know what “the” quantity of money in a measurable sense is. It has become so complex. There is a distinction between Ml, M2, and so on. I don’t think there is such a simple relationship.

When you mean by monetarism that you can instruct the monetary authorities—the Federal Reserve System—to adjust the quantity of money to keep the price level stable, I believe that is correct. But they have to find out by experimentation what they have to do to keep the price level stable. If you understand correctly what Milton Friedman believes, that you can tell them to increase some particular observable quantity by 3% a year, I think it is nonsense. I say this although Friedman is a great friend of mine, and I admire most of his views, but his quantitative approach to economics seems to me to involve a gross oversimplification of what things really are like.

PR: What steps would you recommend to return the United States to stable economic growth and prosperity?

Hayek: What I can say about the United States is exactly the same that I’ve been preaching in England since Mrs. Thatcher has been in power. It is politically possible to cause, by braking inflation, 20% unemployment for six months. It is not politically possible to create 10% unemployment for three years. If you do it quickly even a very high rate of unemployment can be tolerated. If you try to do it slowly and gently, you are bound to fail, because people in the long run will not put up with it. But they will accept it if it comes quickly.

I think every termination of inflation, which is without doubt the most important thing to do, has to be done much more quickly than it has been done in England. It wasn’t Mrs. Thatcher’s fault; she knew she couldn’t get her cabinet to follow her view. She admits as much. In fact, I heard her say, “My one mistake was to go on much too slowly. I ought to have done it much more quickly.” I think the same thing is in a measure true of the United States. You have done much better. You have, since Reagan came into power, reduced inflation very considerably. But one thing I might add is that reducing inflation is of little use unless you bring it down to zero inflation. Anybody who argues that a little inflation is all right, is completely wrong because inflation stimulates things only as it accelerates. If you rely on a little inflation, you are bound to increase it. You are driven into increasing inflation. So the aim must be not to reduce inflation, but as rapidly as possible to get back to a stable price level.

PR: One thing that some of the Reagan advisors have talked about is applying a cost/benefit test to regulations. Is it possible to measure costs and benefits and is cost/benefit analysis a sufficient program for deregulation?

Hayek: If you take “measure” literally, certainly not. But so far as you can estimate them roughly, they must be your guide. I think what you soon arrive at is that for practically all regulations the costs are greater than the benefits. It is simpler to argue against regulations as such than to pretend that you can single out those where clearly the costs are greater than the benefits. There is good sense behind the cost/benefit argument, but I don’t think it’s of great practical value.

PR: What reforms would you propose in our monetary system?

Hayek: Well, I have despaired of ever again finding a way of restraining government abuse of any money which it issues. My proposal to denationalize money was always in a sense Utopian because governments will never freely allow competition in this business. I believe there are ways around this, and my present view—which I hope before long to state in detail—is that there is probably a possibility of not issuing currency but starting with credit accounts under some other name—say, call the unit a “stable” and promise to redeem it with enough of whatever current monies are required to buy a certain list of raw materials. So it doesn’t involve issuing any circulating money, but it enables the holder to keep a stable unit in the form of a credit. Once you’ve succeeded in this, the next step would be issuing credit cards on these accounts. And then you have circumvented the whole monopoly of government.

Since it is politically impractical to deprive the government of its monopoly, you have to circumvent it.

PR: Other than monetary reform, what sort of limits or constraints do you think it is feasible to put on government in a Western democratic society?

Hayek: I think it requires a change in the constitutional arrangement. We have really to redo in a different manner what the world tried to do in the 18th century when they hoped that the principle of the separation of pwers was intended as a restriction on democracy. It hasn’t done so. I think we have to invent a new way.

PR: Professor Hayek, when did you realize the important incentive and information functions played by market prices?

Hayek: Well, it’s a very curious story, in a way, that I was led to put the emphasis on prices as a signal of what to do. It was an essay I wrote in 1936 called “Economics and Knowledge.” That was originally written to persuade my great friend and master, Ludwig von Mises, why I couldn’t accept all of his teaching. The main topic of the essay was to show that while it was perfectly true that what I called the logic of choice—analysis of individual action—was, like all logic, an a priori subject, Mises’ contention that all the analysis of the market was an a priori thing was wrong, because it de-pended on empirical knowledge. It depends on the problem of knowledge being conveyed from one person to another.

Now, curiously, Mises, who was so very resentful generally of critiques by his pupils, even praised my article, but he never seemed to recognize to what extent it meant a diversion from his own fundamental conception. And I never got him to admit what I really imagined to be the case, that I refuted his contention that the analysis of the market economy was an a priori function, that it was a fully empirical matter. What was a priori was a logic behind it—a logic of individual action—that when you pass from the action of one individual, there occurs a causal process of one person acting upon another and learning. And this could never be a priori. This must be empirical. And pursuing this thought is how it started. This led me to investigate how important the prices forming on the market were as guides to individual action. And it is since that date, since what originally was a criticism of my master, Mises, that I have developed this idea of the guide function of prices which 1 regard as more and more important, which I have applied in its effect on price fixing, on rent restriction, on capital investment.

All through, what it comes to is that we can achieve a condition of correspondence of separate effort only if we rely on prices as guides which tell people what to do.

I am personally convinced that the reason which led the intellectuals, particularly of the English-speaking world, to socialism was a man who is regarded as a great hero of classical liberalism, John Stuart Mill. In his famous textbook, Principles of Political Economy, which came out in 1848 and for some decades was a widely read text on the subject, he makes the following statement as he passes from the theory of production to the theory of distribution: “Once the product is there, mankind—socially or individually—can do with it whatever it pleases.” Now, if that were true I would admit that it is a clear moral obligation to see that it is justly distributed. But it isn’t true, because if we did do with that product whatever we pleased, it would never be there again. Because if you ever did it once, people would never produce those things again.

PR: Professor Hayek, we’re hearing much today about the threat to world trade through new rounds of protectionism. What advice would you have to political leaders and also to the people of Western countries who might be concerned about new protectionist measures?

Hayek: Perhaps I am over-optimistic—but one thing has been understood, at least by the more responsible people, that nothing did more to intensify the depression of the 1930s than the return to protectionism. I have not yet found anybody who, once he was reminded of this fact, would still continue to believe that it might be necessary to reintroduce protection.

PR: In your recent interview with the New York Times you said, “Keynes was one of the most intelligent people I knew, but he understood very little economics.” How do you account for his great influence in policy-making circles as well as in the academic community?

Hayek: Well, that is a very profound problem. He was in complete agreement with the philosophical movement which had invaded that generation, what I’d call intellectualist or constructivist ideas derived from many decades of French philosophers. These ideas taught: Don’t believe anything which you cannot rationally justify. This was at first applied to science, but then was equally applied to morals. “Do not regard as binding upon you any morals which you cannot intellectually justify.” Now that meant in the person of Keynes two things which he himself stated. He admitted publicly that he had always been an amoralist. And that involved the famous statement—in the long run we are all dead. Now the great merit of traditional morals is that they have evolved and developed by long-run effects which people never foresaw and understood. And the merits of the institution of private property and of saving are that in the long run those groups that adhered to them prospered.

Similarly, the function of the market system, the benefits of it, are effects beyond our vision—beyond our comprehension. Now, any philosopher who says, “I should admit only what I can rationally justify,” must exclude effects which are not foreseeable, must refuse to acknowledge a moral code which has been evolved because of its de facto effect. The utilitarian theorists believed, and Mises strongly believed, that man had chosen his morals with an intelligent understanding of the good effects. But that is wrong. Most of the effects of the moral we can’t foresee. They are beyond our vision.

The effect is that on the market especially we can serve people whom we do not know. We can profit from the services of people we do not know. In short, we can form an order of activities far exceeding our comprehension. The same is true in our action for the future. Our morals teach that saving is a good thing, because it will help future generations, but that is not a thing we know from experience. All we do know is that those social groups in which saving was a virtue have prospered, and they gradually displaced the others. We simply must realize that our traditional morals are not to be approved because we can show how they are beneficial to us, but only because they have been proved in a process of selection.

By selection I sometimes speak of the natural selection of religions: those religions which preached the right morals survived and enabled the group to multiply. It is not the intelligence of our ancestors that has left us with more efficient morals, but—as I like to express it to shock people—our ancestors were really the guinea pigs who experimented and chose the right ways which have been transmitted to us. It was not necessarily their superior intelligence. Rather, they happened to be right, so their successes multiplied, and they displaced the others who believed in the different morals.

So the difference between Keynes and me is really based on different beliefs about the foundation of ethics. Keynes believed—asserted—”I am only prepared to believed in such rules the effects of which I can see.” But, in fact, civilization has formed by man learning to conform to rules of action, the effects of which were far beyond his vision. I’ve just come up with a new formulation which I rather like, that the invention or the development of the market amounts to the invention of a new sense organ in effect, similar to the evolution of sight in addition to the sense of touch. The sense of touch gives information only about the immediate environment as far as we can feel. The formation of the sense of sight in the evolution of animals enables us to take account of a much wider environment, but one still visible to our senses. Now, the market has become a sort of, as the biologists call it, extra-somatic or external sense organ, which informs us of things of which we are not aware physically. We cannot see the benefits of our action. We cannot see where our benefit come from, but we have developed a mechanism that serves as an organ of information operating very similarly to the sense organs, but enabling us to adjust our action to events which are beyond our sensory perception.

PR: What flaws do you see in current free-market economic thinking?

Hayek: I have two defaults in my activities which I frequently regret. The one is that when Keynes, after I had devoted so much time to criticism of his Treatise on Money, thought out his general theory and told me no one believed in what I spent so much time to criticize, I did not return to the charge and never systematically attacked the General Theory.

And the second thing which I regret is that when Milton Friedman, who was a close colleague and friend, preached positivist economics, I did not attack his positivist economics. Positivist economics is really based on the same idea that we can form appropriate policy on the assumption of complete knowledge of all the relevant facts. In fact, the achievement of the market system is that we can do much better than we would do if we relied only on what we positively know. We can make use of this signaling system, as I call the market, which informs us of things which we cannot directly perceive or which are only transmitted to us—and that applies both spatially and temporally. We learn to adjust ourselves to the events which are beyond our vision spatially, which happen on other continents, and we learn to adjust ourselves to things which will happen in the distant future which we cannot see. The mathematical economists in particular talk of the “given” knowledge, the “given” data. Note how the use is placed to cause reduplication: “Given data” means “given” “givens.” If they suspect that things are not really given to them, they reassure themselves by calling them “given data”; in fact the data are hypothetical assumptions. Nobody knows all of the data. They only become operative and enable us to form an appropriate order by this transmission system of the market, where through many relays and changes what happened somewhere in New Zealand still affects my action by affecting wool prices or land prices and guiding me in what to do.

So it’s all a guide, as I put it before, an information system, something, which, incidentally, Adam Smith said over 200 years. In many respects I find more wisdom in Adam Smith than in most of the later classical economics (not to speak of the famous mathematical economics) which is very beautiful and very true if you assume all of the data are known, but becomes nonsense when you remember that these data are not known to anybody.

PR: Do you think that positivism as a methodology, as a way of thinking, tends to incline economists toward believing that they can fine-tune and intervene in the economy to achieve predictable results?

In England I took a little longer. At the age of 19 years I had been for the first time used on a mission of the colonial office and six months later had left the country. In the United States, where I was for 12 years in Chicago, it never got quite as far because by the time I was asked to sit on a government committee I had already committed myself to leave the country. By moving around the world I have avoided that corruption which government service regularly involves.

And more sadly, I have seen in some of my closest friends and sympathizers—I won’t mention any names—who completely agreed with me, how a few years in government corrupted them intellectually and made them unable to think straight.

I suppose you all know the famous story of the one-handed economist. An American chief of one of the big corporations advertised for a one-handed economist. His associates were very puzzled as to what he meant. He replied, “Oh, I want a person who doesn’t say, ‘on the one hand and on the other.’” And I’m afraid that all the people who have been in government service have become two-handed economists who think in terms of one hand and the other. If one has kept out of government service, one remains a one-handed economist who believes there is a clear way in which we ought to proceed, but one maintains this conviction only so long as one stays out of government. All my friends who have gone into it and stayed for any length of time have, in my sense, been corrupted.

This interview originally appeared in the February 1983 issue of Cato Policy Report.